A Guide to Terminating Employment in India

India's new labor framework — four consolidated labor codes effective November 21, 2025, alongside the Income Tax Act, 2025 — has fundamentally restructured how employers must manage employee termination. This article gives global investors and decision-makers a practical overview of what has changed: retrenchment rules, settlement timelines, and compliance obligations under the new regime.

Contributing Advisor

Krishan Aggarwal

Director, Operations

Termination in India is no longer a straightforward HR decision. It now requires classifying the exit type (resignation, dismissal, fixed-term expiry, or retrenchment), then navigating layered obligations spanning legal review, payroll, statutory compliance, and documentation — with requirements that still vary by establishment type and applicable central or state rules.

Employee termination regulation

For companies operating in India, understanding how the new consolidated framework differs from the previous fragmented regime is now a business-critical priority — directly affecting dispute exposure, penalty risk, and operational continuity. Note that compliance obligations may still vary by establishment type and applicable central or state rules.

State-level Shops and Establishments Acts continue to run alongside these central codes and can materially affect termination outcomes — particularly for commercial establishments.

What is considered as employee termination in India?

The labor codes take a broad rather than prescriptive approach — there is no single consolidated definition of termination. Instead, the framework recognizes five forms of employment exit: employee-initiated resignation, dismissal or discharge for misconduct, retrenchment for business or economic reasons, retirement outside superannuation, and fixed-term contract expiry.

Classification of termination types

A critical operational note: when retrenching for business reasons, the last-hired employee must be the first to exit (last in, first out), and retrenched workers must be given hiring priority if the same or similar roles are filled in the future. Additionally, terminating a pregnant employee or one on maternity leave exposes the employer to non-compliance risk under the Maternity Benefit Act, 2017.

Termination rules for employees

Regardless of the exit type, employers must satisfy both procedural and financial obligations for a termination to be legally valid under the Industrial Relations Code, 2020. The following covers the core compliance rules every organization must follow.

Notice periods and government approval

Notice requirements vary by establishment size and exit type. Standard retrenchment requires one month's notice or wages in lieu. For factories, mines, and plantations averaging 300 or more workers, stricter rules apply: three months' notice or wages in lieu, mandatory prior government approval for retrenchment, lay-off, or closure, and a 90-day advance notice before closure. Workforce restructuring that alters conditions listed in the Third Schedule also triggers a mandatory 21-day waiting period before implementation.

Lawful grounds for dismissal

Under Indian labor law, an employee may be lawfully dismissed for

• Willful insubordination;
• Fraud;
• Dishonesty or theft;
• Deliberate damage to employer property;
• Bribery or illegal gratification;
• Unauthorized absence exceeding 10 days;
• Habitual late attendance; and,
• Disorderly conduct, or work negligence.

Procedural fairness, including a domestic inquiry, is required in all misconduct cases.

Additional compliance rules

• Last-in, first-out: In retrenchments without a separate agreement, the most recently hired employees must exit first; retrenched workers also hold preferential re-employment rights if hiring resumes within one year.
• Maternity protection: Retrenching a pregnant employee or one on maternity leave creates direct exposure under the Maternity Benefit Act, 2017.
• Post-employment restrictions: Non-solicitation clauses are enforceable within limits; non-compete agreements are generally unenforceable under Indian law.
• Leave entitlements: Employees on statutory sick or casual leave (typically 10–15 days annually under state laws) cannot be treated as terminated on those grounds.

The IR Code draws a clear line between the two. Statutory compensation covers retrenchment pay, lay-off compensation (typically 50% of wages plus DA), and closure compensation. Contractual compensation encompasses notice pay, ex-gratia payments, and any additional severance agreed in the employment contract. Both must be fulfilled for a termination to be legally complete. State-level S&E Acts operate alongside the central codes and can materially affect outcomes for commercial establishments — particularly around minimum notice periods, payment-in-lieu obligations, wage settlement timelines, and leave encashment requirements at exit.

How severance and exit payments are taxed

Severance entitlements arise upon retirement, lay-off, retrenchment, or fixed-term contract expiry. Employers should consult legal counsel to confirm obligations specific to their industry, location, and establishment type, as applicable provisions vary.

A compliant severance package under the new regime typically includes:

• Retrenchment compensation — 15 days' average pay per completed year of service (or part exceeding six months)
• Gratuity — payable after one year of continuous service under the Code on Social Security, 2020 (reduced from the previous five-year threshold); capped at INR 2 million for tax exemption purposes
• Leave encashment — compensation for unused earned leave at exit
• Notice pay — one month's wages (or three months' for large establishments), or wages in lieu
• Worker Re-Skilling Fund contribution — employer must deposit 15 days of the worker's last drawn wages within 45 days of retrenchment; administered separately by the government to fund upskilling and employment transition
• Contractual additions — ex-gratia payments, extended health coverage, and career transition support where provided under the employment agreement

Tax treatment of termination payouts

Termination payments are governed by the Income Tax Act, 2025, and are generally treated as salary or profits in lieu of salary — though several components carry partial or full exemptions:

Employees receiving large lump-sum payouts may also be eligible for income-spreading relief to mitigate the effect of progressive tax rates. A key distinction for decision-makers: labor law determines what must be paid; tax law determines how those payments are taxed. Both frameworks must be assessed in parallel when structuring a termination.

Required steps and supporting paperwork

Procedural compliance carries equal weight. Employers must issue proper notices, follow due process in misconduct cases, secure required government approvals, and maintain complete documentation — termination letters, settlement statements, payment records, and employee acknowledgments.

On the tax side, employers must deduct TDS on applicable payments, issue Form 130 (the annual TDS certificate under the Income Tax Rules, 2026, formerly Form 16), and retain all supporting records.

Penalties for non-compliant terminations in India

Non-compliance exposure extends well beyond retrenchment penalties. The Industrial Relations Code prohibits unfair labor practices and provides formal dispute resolution pathways through conciliation officers and industrial tribunals. Where a dismissal or termination is found unjustified, tribunals hold broad remedial powers — including reinstatement, setting aside the termination, or imposing a lesser penalty. Outstanding amounts owed under settlements, awards, or retrenchment provisions are also recoverable through government and collector machinery.

Employee termination checklist

Here’s a quick checklist that outlines some of the procedures that one must follow when terminating employees.

1. Consult the company’s HR policies

Before serving a notice of termination to any employee, one must examine the company’s HR rules and policies. Every company has a specific set of procedures for dealing with different scenarios.

2. Refer to the employee agreement

The employee agreement will contain provisions relating to the notice period, severance pay, compensation and so on that must be offered to the employee upon termination. This agreement is often signed at the beginning, and it serves as an important reference that holds up in a court of law.

3. Serve a notice

Serving a notice is a crucial part of employee termination. The severance notice must be given 30 to 90 days before termination. This notice must be given in writing, stating a clear reason as to why the employee is being terminated.

4. Settle the severance pay

Severance pay is offered to employees who retire, are laid off, or reach the end of the contractual agreements.

• One month’s salary must be paid to employees who have worked for a year or more.
• For mass termination in protected sectors, three months of wages must be offered to employees.
• Code on Social Security, 2020 entitles employees to gratuity payment after one year of continuous service.
• Industrial Relations Code Bill, 2020, also states that retrenched (involuntarily dismissed) workmen must be given 15 days of severance pay for each year of service that they have completed.

5. Conduct an exit interview

Exit interviews help an organization to gain feedback and evaluate their work culture, environment, ethics etc. It also helps organizations to narrow down their areas of improvement when it comes to enhancing employee experience in the office.

Employee protection and court jurisdiction in case of disputes

An employee who has been dismissed has a legal right to appeal to their jurisdictional authority. The employee could appeal to a court for one of the following reasons:

• The employer has terminated an employee without stating a specific reason;
• The employee has not been proven to be guilty of misconduct and pleads innocence; or
• The employee feels that their dismissal was based on unfair grounds.

When an employee seeks redressal of any of the following grievances, they must first establish a case and seek the approval of their local labor authorities. Once the approval is granted, the case may be overseen by jurisdictional conciliation officers, industrial tribunals, or labor courts.

Most workforce disputes in India take anywhere between six months to two years to get resolved.